Academic journal article Accounting & Taxation

Are Buybacks Increasing Eps?

Academic journal article Accounting & Taxation

Are Buybacks Increasing Eps?

Article excerpt

ABSTRACT

Trends indicate that treasury shares or buyback shares are gaining new momentum and intensity and maybe effecting reported earnings per share. This study was undertaken by evaluating the buyback activity of the Standard and Poor's 500, for the period of 2005-2008 to the Hribar et al (2004 and revised 2006) study of buybacks for their period of 1988-2001. Their study reflected that buybacks were not dominant due to their tri-model of low number of share being repurchased, the high number of companies experiencing a loss and high P/E multiples.. This study experienced greater frequency and intensity of buybacks, due to a reversal in the three conditions being a larger number of shares purchased,) lower incident of losses and lower P/E multiples. The findings are that buybacks are more frequent, more intense, and are having an increased accretive effect on EPS. As a solution proposed here is a new EPS model that reports EPS in segments; those from operations and those from buybacks when the effect is $.01 or more. This new EPS model is responsive to the changing financial landscape and is deserving of attention at this time of international accounting assessment.

JEL: M41, G35

KEYWORDS: Buybacks, Treasury Shares, Stock Repurchases, Earnings Per Share,

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

When a company buys its own stock back, the repurchased stock is referred to as treasury stock in accounting terminology. The more generic term of this is "buybacks". One could suppose that the term comes from putting it back into the treasury or as the Merriam Webster dictionary defines treasury as a "place in which stores of wealth are held." The Merriam Webster defines treasury stock as stock that is repurchased and held as an asset. This is partially untrue since treasury stock is not held as an asset but as negative equity. When treasury stock is purchased, the account Treasury Stock is debited and Cash is credited. However, the treasury-stock account is not included in the asset section of the balance sheet but it is included as a contra-equity account since it is subtracted from equity. Besides, any gains or losses realized from the purchase or sale of treasury stock are not reported on the income statement, even though they have tax consequences. The gains or losses are added or subtracted from equity and circumvent the income statement. Treasury stock does not vote and it does not collect dividends. It is more or less taken out of circulation for the time being.

Treasury stock affects earnings per share (EPS) since the denominator of the EPS is outstanding stock, which excludes treasury shares. Thus when treasury shares are purchased the outstanding stock is reduced; and if it is of magnitude, it may result in increasing EPS even though net income has not increased. The following is the formula for EPS.

... (1)

Surprisingly, EPS was not originally an accounting item; rather it emerged from the finance community. The financial community was the creator of EPS, which is used to report as a one-liner the results of a company's performance. In actuality, it reports on the income of a company and gives no reflection of the resources used to create those returns. In the earlier days of accounting development the Committee on Accounting Procedure, specifically Accounting Research Bulletin (ARB) No. 32 in 1947 "admonished financial statement users against placing undue prominence on a single net income or earnings per share amount". One item of the EPS that is an equity issue is its treasury shares. In the past, they were not of consequence. However, the economic landscape is continually changing, especially in this regard specifically since 2005. According to Horngren, (1974):

The earning ( net income) applicable to each share of common stock is perhaps the single most-quoted figure in an annual report, primarily because investors are so heavily interested in the effect of such earning on the market price of the stock. …

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